The Crumbling of Free Trade — And Why It’s a Good Thing

Free Trade

One thing is for certain already: the present international trading order will not be here in ten years, and quite likely not in five. The unsustainable American trade deficit alone makes this a certainty.

Since the end of the Cold War, and accelerating after NAFTA in 1994, that order has consisted in ever-expanding “free” trade worldwide — which in reality is a curious mixture of genuinely free trade practiced by the United States and a few others with the technocratic mercantilism of surging East Asia and Germanic-Scandinavian Europe.

From America’s point of view, this order is free trade, at least on the import side of the equation, so it is as free trade that we must criticize it, prepare to celebrate its passing, and investigate what should replace it.

Our free trade policy is the answer to a question that currently has most mainstream economists scratching their heads: what killed the great American job machine? This policy has been partly responsible for increasing inequality in the United States and the gradual repudiation of our 200-year tradition of broadly shared middle-class prosperity. It is a major player in our rising indebtedness, community abandonment, and a weakening of the industrial sinews of our national security.

America’s economy today continues to struggle to emerge from recession because our trade deficit — fluctuating around $500 billion a year for a decade now — acts as a giant “reverse stimulus” to our economy. It causes a huge slice of domestic demand to flow not into domestic jobs, thus domestic wages and thus more demand, but into imports, therefore foreign wages, and therefore a boom in Guangdong, China; Seoul, South Korea; Yokohama, Japan; and even Munich — not Gary, Indiana; Fontana, California; and the other badlands of America’s industrial decline. Our response? Yet more stimulus, leading to an ever-increasing overhang of debt, both foreign and domestic, the cost of whose servicing then exerts its own drag on recovery.

The American economy has, in fact, entirely lost the ability to create jobs in tradable sectors. This cheery fact comes straight from the Commerce Department. All our net new jobs are in nontradable services: a few heart surgeons and a legion of bus boys and security guards, most of them without health insurance or retirement benefits. These are dead-end jobs, and our economy as a whole is also being similarly squeezed into dead-end industries. The green jobs of the future? Gone to places like China where governments bid sweeter subsidies than Massachusetts can afford. Nanotechnology? Perhaps the first major technology in a century where America is not the leading innovator. Foreign subsidies are illegal under WTO rules, but no matter: who’s going to enforce them when corporate America is happily lapping at their very trough?

All the complaints just mentioned are familiar to the public, but they fly in the face of a sanctified myth that the superiority of free trade is a known truth of social science. Supposedly, it was proved long ago that protectionism is just a racket for the benefit of special interests at the expense of consumers.

Never mind that every developed nation, from England to South Korea, and including the United States, became a developed nation by means of this policy. That little piece of economic history is airbrushed out of the picture in favor of the Cold War myth of the absolute superiority of perfectly free markets. America never embraced this myth on its merits, merely as a tactical device to prop up the noncommunist economies of the world and make them dependent upon us.

The cycle repeats: China today is reenacting this 400-year-old mercantilist playbook, which was born among the city-states of Renaissance Italy and never quite forgotten.

Economic theory will be sorted out eventually. Thanks to the work of a small, brave group of dissident economists — scholars like Ralph Gomory, William Baumol, Erik Reinert, and Ha-Joon Chang — the credibility of free trade as a theoretical doctrine is crumbling, and the discipline will eventually change its mind. But it will almost certainly be a lagging indicator, ready to vindicate policy forged in crisis well after the dust has settled. Academia is a superb rationalizer, and will doubtless find a way to avoid embarrassing questions about its own past positions when it teaches undergraduates twenty years from now that free trade is a delusion and a mistake.

What’s wrong with free trade? A whole host of problems, many of them long known to economists but assumed in recent decades to be unimportant.

The technical plot thickens here fast, but we can begin by noting that any serious discussion of free trade must confront David Ricardo’s celebrated 1817 theory of comparative advantage, whose tale of English cloth and Portuguese wine is familiar to generations of economics students. According to a myth accepted by both laypeople and far too many professional economists, this theory proves that free trade is best, always and everywhere, regardless of whether a nation’s trading partners reciprocate.

Unfortunately for free traders, this theory is riddled with dubious assumptions, some of which even Ricardo acknowledged. If they held true, the hypothesis would hold water. But because they often don’t, it is largely inapplicable in the real world. Here’s why:

Ricardo’s first dubious assumption is that trade is sustainable. But when a nation imports so much that it runs a trade deficit, this means it is either selling assets to foreign nations or going into debt to them. These processes, while elastic, aren’t infinitely so. This is precisely the situation the United States is in today: not only does it risk an eventual crash, but in the meantime, every dollar of assets it sells and every dollar of debt it assumes reduces the nation’s net worth.

Ricardo’s second dubious assumption is that the productive assets used to generate goods and services can easily be shifted from declining to rising industries. But laid-off autoworkers and abandoned automobile plants don’t generally transition easily to making helicopters. Assistance payments can blunt the pain, but these costs must be counted against the purported benefits of free trade, and they make free trade an enlarger of big government.

The third dubious assumption is that free trade doesn’t worsen income inequality. But, in reality, it squeezes the wages of ordinary Americans because it expands the world’s effective supply of labor, which can move from rice paddy to factory overnight, faster than its supply of capital, which takes decades to accumulate at prevailing savings rates. As a result, free trade strengthens the bargaining position of capital relative to labor. And there is no guarantee that ordinary people’s gains from cheaper imports will outweigh their losses from lowered wages.

The fourth dubious assumption is that capital isn’t internationally mobile. If it can’t move between nations, then free trade will (if the other assumptions hold true) steer it to the most productive use in our own economy. But if capital can move between nations, then free trade may reveal that it can be used better somewhere else. This will benefit the nation that the capital migrates to, and the world economy as a whole, but it won’t always benefit us.

The fifth dubious assumption is that free trade won’t turn benign trading partners into dangerous trading rivals. But free trade often does do this, as we see today in China, whose growth is massively dependent upon exports. This is especially likely when trading partners practice mercantilism, the 400-year-old strategy of deliberately gaming the world trading system by methods like currency manipulation and hidden tariffs.

The sixth dubious assumption is that short-term efficiency leads to long-term growth. But such growth has more to do with creative destruction, innovation, and capital accumulation than it does with short-term efficiency. All developed nations, including the United States, industrialized by means of protectionist policies that were inefficient in the short run.

What is the implication of all these loopholes in Ricardo’s theory? That trade is good for America, but free trade, which is not the same thing at all, is a very dicey proposition.

book

For a fuller discussion of free trade, read Ian Fletcher's book (click on the cover above to learn more).

Beyond the holes in Ricardo, there is an entire new way of looking at trade growing up around the theoretical insights of Ralph Gomory and William Baumol of New York University. The details are technical, but the upshot is they have managed to bridge the gap between the Pollyannaish “international trade is always win-win” Ricardian view and the overly pessimistic “international trade is war” view. The former view is naive; the latter ignores the fact that economics precisely isn’t war because it is a positive-sum game in which goods are produced, not just divided, making mutual gains possible.

So at long last, someone has given us a theoretical framework that can accommodate economic reality as we actually experience it, not just lecture us on what “must” happen as Ricardianism does. It’s both a dog-eat-dog and a scratch-my-back-and-I’ll-scratch-yours world. Economics has finally given common sense permission to be true. Ironically, their sophisticated mathematical models are actually closer to the thinking of the man on the street than those they replaced.

There is an appropriate policy response. For starters, the United States should apply compensatory tariffs against imports subsidized by currency manipulation, an idea that originated with Kevin Kearns of the U.S. Business and Industry Council and was passed by the House of Representatives in the previous Congress. Also essential is a border tax to counter foreign export rebates implemented by means of foreign value-added taxes.

Perhaps even more important than the pure economics of free trade is its political economy (an older and more accurate term). For the fundamental reality of free trade is that it relieves corporate America from any substantial economic tie to the economic well-being of ordinary Americans. If corporate America can produce its products anywhere, and sell them anywhere, then it has no incentive to care about the capacity of Americans to produce or consume. Conversely, if it is tied to making a profit by selling goods made by Americans to Americans, then it has a natural incentive to care about American productivity and consumption.

Productivity and consumption are prosperity. The rest is details.

Right now, America is confronting any number of long- and short-term economic problems with one hand tied behind its back: corporate America is, increasingly, quietly indifferent to America’s economic success. This must change. While any proposals to end the K Street dictatorship in America’s public life are welcome, the reality is that mechanical reforms are less likely to touch on true fundamentals than realigning the economic incentives they reflect.

This is not a utopian project. In fact, it has already been accomplished, during the long 1790-1945 era of American protectionism. America wandered away from Founding Father Alexander Hamilton’s vision of a relatively self-contained American economy in order to win the Cold War. We threw our markets open to the world as a bribe not to go communist. If we fail to return to a policy of strategic, not unconditional, economic openness, we may lose the next Cold War — to a Confucian authoritarianism no less opposed to the idea of a free society than Marxism, and considerably more efficient.

Ian Fletcher is a senior economist at the San Francisco office of the Coalition for a Prosperous America. His specialties are trade economics, protectionism, and industrial policy. He is the author of "Free Trade Doesn't Work: What Should Replace It and Why" (http://www.freetradedoesntwork.com/). He was previously an economist in private practice. You can follow his work at huffingtonpost.com/ian-fletcher.
 
tags: Economy/Poverty/Wealth, Global Capitalism   
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9 Responses to The Crumbling of Free Trade — And Why It’s a Good Thing

  1. Elaine H. May 14, 2011 at 5:10 pm

    If free trade is crumbling away, why is the U.S. considering more NAFTA style free trade agreements with South Korea, Panama, and Colombia?
    South Korea is another currency manipulator and there is no prohibition against this in the latest proposed free trade deal. Further, S. Korea’s economy is largely export driven and imports to America of Korean auto parts have exceeded our exports by 14-1 for the last decade. In 2009, approximately 4,000 passenger vehicles were exported to Korea from the U.S. but the U.S. imported hundreds of thousands of vehicles from Korea.
    The FTA also allows its benefits to accrue to autos that contain only 35% U.S. or Korean content, with 65% of components coming from unknown, third countries, such as China or Mexico, assembled in S. Korea, and then shipped to the U.S., (eventually duty free).
    Panama is one of the world’s worst tax havens and home to tens of thousands of corporations that shelter profits in Panama.
    Colombia is a country where union activists are murdered and, in fact, many past murders remain unprosecuted. Yet there are no consequences in this trade agreement related to a loss of trade benefits if this behavior continues.
    How is free trade crumbling when we’re staring at these agreements which could be voted on at any time?
    The deindustrialization of America and the abandonment of our working men and women to slave labor countries continues and this was a premeditated destruction.

    • Judith May 24, 2011 at 3:18 pm

      TThese trade deals for America are a disaster. They are to encourage others to do them so they become part of the WTO. This organization is good for them and bad for us. It is cheap labor for corporations to move there from here. It is an attack on our unions and freedoms for World Order Government.

      If our leaders cared about our welfare they would get out of that so called trade group. They win…we lose.

  2. jerry blair May 14, 2011 at 5:16 pm

    I couldn’t agree with Ian more. A very good article.

    Here’s a statistic. There’s more high IQ geniuses in school in China than there are school children in the U.S.

    We had better change tactics.

  3. Elaine H. May 14, 2011 at 5:16 pm

    May I suggest that all of you who read this call your Congressional reps to oppose these proposed agreements as I have done?

    Again and again, free trade deals have been pitched to us with lots of promises of good-paying American jobs but have, instead, been a huge job killer. We are forced to compete with an inexhaustible pool of low wage labor to produce and dump all over the U.S. market which has become the market of last resort for the world.

  4. Edward Gershon Cherlin May 14, 2011 at 6:38 pm

    [sigh] One cannot lay out or discuss the entire theory of Competitive Advantage in an article, and much less so in a comment. Nor is their room to point out every error of fact and interpretation made by the author. This article is riddled with errors, but worse than that it ignores essential political facts.

    Mr. Fletcher was previously Research Fellow at the U.S. Business and Industry Council, and before that has been a hedge fund manager.

    http://www.prosperousamerica.org/ian_fletcher.html
    http://en.wikipedia.org/wiki/United_States_Business_and_Industry_Council

    The United States Business and Industry Council (USBIC) is an NGO which lobbies on behalf of family owned and closely held US manufacturing companies.

    Thus its interests are opposed to the multinational corporations, and as far as I can tell are opposed to the people, too, regardless of the rhetoric about jobs.

    I favor Free Trade, with neither obstacles nor favors intended to aid particular companies or industries in particular countries. Not the pretense of Free Trade that corporate interests promote while bellying up to the trough for more goodies from their governments, whom they bribe and cajole to ignore the public welfare.

    For trade to be Free, there must not be unregulated or reverse-regulated economic actors with excessive economic power. Excessive economic powers include the ability to set prices without regard to the balance of Supply and Demand; the ability to exclude others from a market; the ability to lock up technology and make it unavailable to others; and more that I must leave the interested to look up. Reverse regulation includes subsidies, price supports, and ignoring of physical and financial safety and environmental requirements. In particular, it includes regulatory capture, in which the regulators come from the industry regulated, and look forward to returning to it at a higher level.

    http://en.wikipedia.org/wiki/Perfect_competition

    How are we doing?

    Obstacles and favors: Subsidies, price supports, export restrictions on security software…

    Exclusion from markets: Secret testing of proprietary voting machine software and other critical infrastructure at considerable expense; national boundaries, discriminatory import laws, and immigration restrictions. It isn’t a Free Market if you can’t get to it.

    Locking up technologies: Patents, including deliberate underfunding of the Patent and Trademark Office. Copyrights, excluding poor countries from using essential education materials for unconscionable periods (life of the author plus 75 years).

    I can go on in this vein for weeks at a time.

    I think somebody should try Free Trade. That somebody is not and never has been the United States. It is of course obvious that my program has no political chance among existing governments. I do not look for a political solution in the present environment.

    I work on education for all children in the world, in the One Laptop Per Child manner. It will go further to breaking down barriers of nationality, ethnicity, religion, and economics than anything previously proposed, because it will allow the children to get in contact with each other for social, educational, and later on business and civil society cooperation. It should bring an end to poverty. It is at that point, where the fearful no longer need to fear a tsunami of the desperately poor, when countries will think seriously about opening their borders and their economies.

    Having disagreed with the author of this post and book on almost every point, I wish to point out that he is correct, in my opinion, in saying that the global economy will be quite different in a decade, and much more so in two. Just not for the reasons he gives, and not in the direction he proposes.

  5. P Brandt May 14, 2011 at 7:19 pm

    The biggest assumption we all forget about US “free trade” is the fact that the US military’s first job is to make sure the sea lanes stay open for all that shipping.

    A big part of this job is also coercion, as Marines are based all over the world in “trouble spots” where US corporate property needs them for protection. Those “trouble spots” are a direct result of the despotic governments these corporations and our military aid prop up, who block democracy, crush collective bargaining, and concentrate wealth from extraction exports. They are also the result of arms trafficking for which for some reason George W Bush’s appointed to the UN John Bolton and Jesse Helms worked hard in their careers to block UN or other kinds of remedies for the arms trafficking which destroys these societies in which US extractors have to do business. Why would that be? What campaign contributors here need arms trafficking blocked all over the developing world?

    These conditions are the root cause of the Iranian Revolution, and countless “civil” wars everywhere.

    Coca-Cola and Pepsi Co bottling franchises have always been the easiest way of co-opting elite families in these countries.

    Where all else fails, there is plenty of evidence out there of CIA and Special Forces operatives implicated in coups, terrorism, etc.

    There are NO “free markets” in US capitalism. Coercion and anti-democracy are the mainstays of this business model. The business model itself is the root cause of poverty, civil war, and dictatorship.

  6. Jimbo in limbo May 15, 2011 at 5:19 pm

    The problem with “the theoretical insights of Ralph Gomory and William Baumol of New York University” is that they’re up against the lobbyists of Wal-Mart, which itself likes cheap imports and hobbled labor.

  7. margery kronengold May 16, 2011 at 1:06 pm

    no comment at the moment

  8. goldie klugman May 18, 2011 at 8:19 am

    Good article!

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